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Supreme Court Decision in Gabelli v. SEC is a Boon for Fraudsters

In a unanimous 0-9 decision, the Supreme Court today reversed the 2nd Circuit in the case of Gabelli v. SEC, holding that the “discovery rule” does not apply for punitive fraud actions brought by government enforcement agencies. Our previous blog post describes the case and references the amicus brief that Occupy the SEC filed in the case.

The Supreme Court’s decision effectively reduces the allowable timeframe within which the government can bring penalty actions against fraudsters. This will allow wrongdoers to escape liability for no good reason other than the fact that the applicable government enforcement agency did not bring a suit in time. The Court explicitly acknowledges this possibility:

“We have . . . concluded that ‘even wrongdoers are entitled to assume that their sins may be forgotten.'”

Agencies like the SEC have spare resources. An increased burden has been placed on the SEC with the passage of Dodd-Frank. Meanwhile there have been sustained efforts in Congress to limit the agency’s funding. The obvious consequence of this is that the SEC will bring fewer fraud actions within the shortened 5 year window. This decision is essentially a “get out of jail free” card for untold numbers of fraudsters.

Sadly the court did not seem to take cognizance of this reality, or the justness of such an outcome. It instead focused heavily on the absence of any prior caselaw specifically applying the discovery rule to a government enforcement action. But that is circular reasoning. A case comes before the Supreme Court only because it presents a novel question. If there is already extensive caselaw on a particular legal issue, the Court is unlikely to grant certiorari (i.e. decline to hear the case in the first place). So the Court should not have placed so much emphasis on the fact that the discovery rule had not been applied to government actions before. The discovery rule has been applied for centuries, and the Court could have (and should have) extended it to government penalty actions. After the Gabelli decision, private plaintiffs can benefit from the discovery rule, but the government, which represents the public, cannot.

The discovery rule starts the clock on the statute of limitations when the agency should reasonably have discovered the fraud. On the one hand, the Court questioned how it could determine whether a large federal agency actually discovered a fraud (“when does ‘the Government’ know of a violation? Who is the relevant actor? “). But the same decision gave many examples of how the SEC has the power to subpoena documents and conduct investigations. Obviously these actions (subpoenaing documents and conducting investigations) are clear indications of when the Government “knows” about a violation. These actions could easily establish the start date for the discovery rule.

All in all, the decision sets a troubling precedent. It also reinforces the dire need for the SEC and other enforcement agencies to receive more funding. The deck is now stacked against them.